H.P. Unit Sheds Stepchild Status to Take on Cisco

Tuesday

Nov 25, 2008 at 12:01 AMNov 26, 2008 at 4:20 AM

Hewlett-Packard is attacking Cisco to capture a larger chunk of the $20 billion market for local area network and wireless switches.

ASHLEE VANCE

When Mark V. Hurd took over as chief executive of Hewlett-Packard in 2005 and started looking at the company’s businesses, he found a neglected little unit called ProCurve that made networking gear used to connect computing systems on corporate campuses.

ProCurve had been stifled under H.P.’s former chief executive, Carleton S. Fiorina, who served on the board of Cisco Systems, the dominant player in the industry. Ms. Fiorina supported the traditional alliance between H.P. and Cisco, in which H.P. sold computers and Cisco sold network equipment to the same customers.

Mr. Hurd decided on a different approach. He championed the ProCurve business, helping nurture it from a few hundred million dollars in annual sales to about $1 billion. It is now H.P.’s second-most-profitable business and one of its fastest-growing.

Now H.P. is directly attacking Cisco in a bid to capture a larger chunk of the $20 billion market for local area network and wireless switches. “H.P. has declared war,” said Mark Fabbi, a networking analyst at the research firm Gartner. “H.P. has the potential to completely change the dynamics of the networking industry.”

Hewlett-Packard’s strategy with ProCurve — expand revenue and profit by biting into a leader’s lucrative franchise — is vintage Mark Hurd. And it offers some insights into how the company has outperformed its peers financially even as the technology industry faces a global slowdown.

On Monday, H.P., the largest maker of computers and printers, formally reported net income of $2.11 billion, or 84 cents a share, for its fiscal fourth quarter, about flat with the previous year. Revenue rose 19 percent to $33.6 billion. Laptops, compact servers and software were strong, as H.P. continued to pressure rivals like Dell and I.B.M.

Although the company did not break out figures for ProCurve, which was a tiny part of H.P.’s revenue of $118 billion for the 2008 fiscal year, Mr. Fabbi estimated the business had gross profit margins of about 50 percent — second only to the lucrative printer cartridges that are H.P.’s cash cow.

He said H.P.’s network hardware revenue had grown 40 percent over the last two quarters, cementing the company’s position as the No. 2 player in the market. H.P., based in Palo Alto, Calif., now accounts for 7 percent market share by revenue, compared with Cisco’s 77 percent.

In June, Mr. Hurd made his ambitions for ProCurve clear by selecting a senior vice president of H.P., Marius Haas, as the new chief of the networking business. Mr. Haas had spent the previous five years as the head of H.P.’s strategy and corporate development team, overseeing more than 25 mergers and acquisitions. The last deal cleared by Mr. Haas was the $13.9 billion purchase of Electronic Data Systems, a computer services giant that H.P. is using to challenge I.B.M., the leader in that business.

This month, H.P. placed the ProCurve line under its Technology Solutions Group, the $38 billion business run by an executive vice president, Ann Livermore. “This was one of our best-kept secrets for a long time,” Mr. Haas said. “Now, everybody knows about it.”

Cisco, based in San Jose, Calif., declined to directly discuss H.P.’s push into its core business. Ish Limkakeng, a vice president in Cisco’s switching group, said the company “takes all competitors very seriously.”

But while Cisco plays down the changing competitive situation, customers have taken notice.

Westminster College in Fulton, Mo., has switched to H.P. as a supplier. “A lot of people in the industry say that Cisco has a certain arrogance,” said Scott Lowe, the college’s chief information officer. “With real competition in the marketplace, I think you will see there is a desire for people to get away from that arrogance.”

Some of Cisco’s strongest critics are hardware resellers. They are hoping that a muscular competitor like H.P. will place pressure on Cisco to give them more favorable sales and services terms. Although Cisco itself makes about 70 percent gross profit margins on its LAN switching gear, the resellers “can’t make any money on Cisco,” said Brad Reese, who sells refurbished Cisco equipment.

Under Ms. Fiorina, H.P. and Cisco had an unusually close partnership. H.P. actually rewarded sales representatives for selling Cisco’s network hardware without offering similar compensation for H.P.’s own products.Despite its stepchild status, the ProCurve business grew during Ms. Fiorina’s tenure. H.P. became a trusted supplier of switch equipment used by small and midsize companies, outflanking suppliers like Nortel Networks and 3Com.

Upon his arrival, Mr. Hurd changed the way H.P. sold its network hardware. Rather than being encouraged to sell Cisco products, H.P. sales representatives were rewarded for selling H.P. equipment.

“You should be assured that Mark is a very pragmatic guy and wants people incented to sell H.P.,” Mr. Haas said. “Cisco has had such a dominant position, but the doors are opening.”

Cisco continues to receive high marks for the breadth and quality of its products. Still, it has largely been able to operate in this part of the market without facing a competitor of its size or stature.

Analysts also say that H.P.’s networking plans may receive a lift from the addition of E.D.S., which assembles and manages computer systems for corporate customers and has done a lot of business with Cisco, possibly even doubling sales of its network products in less than two years.

“H.P. is a much more formidable challenger to Cisco, and it has sent an obvious message,” said Nikos Theodosopoulos, an analyst at UBS Securities.

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